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Treasury Consulting > Risk, have you got its measure?

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Published: 4th January 2010 by William Webster

Treasury is a place that deals with money. Whenever you do this there are risks. But it's unlike other forms of business because it uses leverage. In simple terms a small amount of capital covers a large amount of risk. Even the most straight forward of treasuries use this principle. Get it right and you make money. But mistakes will cost you dearly. Therein lies a problem.

You can eliminate almost all of the risk you have. But I bet you won't do it. That's because it's too costly. 

So just how much risk do you want to take? That may seem like an innocent question but it can get you in a whole lot of trouble. Setting the risk appetite is a board responsibility. Decisions should be reflected in terms of capital or profitability and not all risks will be treated equally.

Establishing a limit framework within the parameters of your risk appetite isn't straight forward either. There are many different ways to control market, liquidity, credit, basis, behavioural and operational risks. Could you improve on what's available?

Over reliance on backward looking historic data (and the models that use it) is now considered a major weakness in risk control. That's why there is emphasis on stress testing. The scenarios need to be rigorous and they should apply to your business. What do the stresses tell you about your limits? Are the outcomes consistent with your risk appetite or do you need to reconsider?

Are stress effects offset by sound contingency planning? The mitigating effects can only be justified if it's well prepared, the assumptions should be supported and where possible tested.

Does it tell you that some extreme events take you to a place that is beyond your risk appetite?

Have you noticed there are a lot more reports? Every firm now uses a mixture of gaps, value at risk, earnings at risk, deltas, gammas, expected defaults, liquidity ratios etc. All of these have both strengths and weaknesses. They depend on the methods used. Do you understand what they can and cannot tell you? It's not me you have to convince it's the regulator.

Additionally almost all risk packs contain serious errors and that's a fact. Do you know where they are?

If this isn't enough even compliance can lead to unintended consequences. Some of the new legislation insisting that you buy gilts for liquidity is far from risk free. It will almost certainly increase some of your risks and cost you more than just negative carry.

Just another unintended consequence and it demonstrates that if you want to manage treasury risk you need to have experience and expertise.

If you work in a smaller firm there simply aren't the resources available. Does it make you feel a little uneasy? I expect it does.

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